OCT 17 World Economic and Financial Surveys Global Financial Stability Report Global Financial Stability Report Is Growth at Risk? Is Growth at Risk? Is Growth OCT 17 IMF Global Financial Stability Report, October 2017 INTERNATIONAL MONETARY FUND World Economic and Financial Surveys Global Financial Stability Report October 2017 Is Growth at Risk? INTERNATIONAL MONETARY FUND ©2017 International Monetary Fund Cover and Design: Luisa Menjivar and Jorge Salazar Composition: AGS, An RR Donnelley Company Cataloging-in-Publication Data Joint Bank-Fund Library Names: International Monetary Fund. Title: Global financial stability report. Other titles: GFSR | World economic and financial surveys, 0258-7440 Description: Washington, DC : International Monetary Fund, 2002- | Semiannual | Some issues also have thematic titles. | Began with issue for March 2002. Subjects: LCSH: Capital market—Statistics—Periodicals. | International finance—Forecasting—Periodicals. | Economic stabilization—Periodicals. Classification: LCC HG4523.G557 ISBN 978-1-48430-839-4 (Paper) 978-1-48432-056-3 (ePub) 978-1-48432-057-0 (Mobipocket) 978-1-48432-059-4 (PDF) Disclaimer: The Global Financial Stability Report (GFSR) is a survey by the IMF staff published twice a year, in the spring and fall. The report draws out the financial ramifications of economic issues high- lighted in the IMF’s World Economic Outlook (WEO). The report was prepared by IMF staff and has benefited from comments and suggestions from Executive Directors following their discussion of the report on September 21, 2017. The views expressed in this publication are those of the IMF staff and do not necessarily represent the views of the IMF’s Executive Directors or their national authorities. Recommended citation: International Monetary Fund. 2017. Global Financial Stability Report: Is Growth at Risk? Washington, DC, October. Please send orders to: International Monetary Fund, Publications Services P.O. Box 92780, Washington, DC 20090, U.S.A. Tel.: (202) 623-7430 Fax: (202) 623-7201 E-mail: [email protected] www.bookstore.imf.org www.elibrary.imf.org CONTENTS Assumptions and Conventions vi Further Information and Data vii Preface viii Foreword ix Executive Summary x IMF Executive Board Discussion Summary xiv Chapter 1 Is Growth at Risk? 1 Financial Stability Overview 1 Large Systemic Banks and Insurers: Adapting to the New Environment 2 Monetary Policy Normalization: A Two-Sided Risk 17 Has the Search for Yield Gone Too Far? 23 The Rise in Leverage 32 Could Rising Medium-Term Vulnerabilities Derail the Global Recovery? 42 Box 1.1. A Widening Divergence between Financial and Economic Cycles 47 Box 1.2. Cyberthreats as a Financial Stability Risk 49 References 51 Chapter 2 Household Debt and Financial Stability 53 Summary 53 Introduction 54 How Does Household Debt Affect Macroeconomic and Financial Stability? 56 Developments in Household Debt around the World 58 Financial Stability Risks of Household Debt: Empirical Analysis 62 Conclusions and Policy Implications 70 Box 2.1. Long-Term Growth and Household Debt 72 Box 2.2. Distributional Aspects of Household Debt in China 73 Box 2.3. A Comparison of US and Canadian Household Debt 75 Box 2.4. The Nexus between Household Debt, House Prices, and Output 77 Box 2.5. The Impact of Macroprudential Policies on Household Credit 79 Annex 2.1. Data Sources 81 Annex 2.2. Methodology 84 References 87 Chapter 3 Financial Conditions and Growth at Risk 91 Summary 91 Introduction 92 Financial Conditions and Risks to Growth: Conceptual Issues 93 How Do Changes in Financial Conditions Indicate Risks to Growth? 96 How Well Do Changes in Financial Conditions Forecast Downside Risks to Growth? 100 Policy Implications 108 Annex 3.1. Financial Vulnerabilities and Growth Hysteresis in Structural Models 109 Annex 3.2. Estimating Financial Conditions Indices 113 International Monetary Fund | October 2017 iii GLOBAL FINANCIAL STABILITY REPORT: IS GROWTH AT RISK? Annex 3.3. The Conditional Density of Future GDP Growth 115 References 116 Tables Table 1.1. Sovereign and Nonfinancial Private Sector Debt-to-GDP Ratios 34 Annex Table 2.1.1. Countries Included in the Sample for Household Debt and Data Sources 81 Annex Table 2.1.2. Household Survey Data Sources 82 Annex Table 2.1.3. Description of Explanatory Variables Used in the Chapter 83 Annex Table 2.2.1. Logit Analysis: Probability of Systemic Banking Crisis 84 Annex Table 2.2.2. Panel Regression Estimates for Three-Year-Ahead Growth Regression on Household Debt and Policy Interaction Variables 86 Table 3.1. Forecast of GDP Growth Distribution for the Global Financial Crisis with and without Financial Conditions Indices 104 Table 3.2. Market Consensus Forecasts for the Global Financial Crisis Were Considerably More Optimistic Than Forecasts Based on Financial Conditions 104 Table 3.3. Forecast of GDP Growth Distribution for the Global Financial Crisis: Comparing Partitioned and Univariate Financial Conditions Indices with Autoregressions 105 Annex Table 3.2.1. Country Coverage 113 Annex Table 3.2.2. Data Sources 114 Annex Table 3.2.3. Partitioning of Financial Indicators into Groups 115 Figures Figure 1.1. Global Financial Stability Map: Risks and Conditions 2 Figure 1.2. Global Financial Stability Map: Assessment of Risks and Conditions 3 Figure 1.3. Search for Yield, Asset Valuations, and Volatility 4 Figure 1.4. Global Systemically Important Banks: Significance and Business Model Snapshot 6 Figure 1.5. Global Systemically Important Banks: Capital, Liquidity, and Legacy Challenges 7 Figure 1.6. Global Systemically Important Banks: Market Activity 9 Figure 1.7. Global Systemically Important Banks’ International Activity 10 Figure 1.8. Global Systemically Important Banks: Financial Performance Gaps 12 Figure 1.9. Life Insurance Companies’ Profitability and Capital 13 Figure 1.10. Changes in Life Insurance Companies’ Business Models 14 Figure 1.11. Life Insurers’ Market Valuations and Risk Outlook 16 Figure 1.12. Simulated Mark-to-Market Shocks to Assets and Liabilities 17 Figure 1.13. Central Bank Balance Sheets and the Sovereign Sector 19 Figure 1.14. Policy Rates, 10-Year Government Bond Yields, and Term Premiums 20 Figure 1.15. Emerging Market Economy Capital Flows 22 Figure 1.16. Global Fixed Income Markets and US Corporate Credit Investor Base 24 Figure 1.17. Emerging Market Economies: Debt Issuance, Portfolio Flows, and Asset Prices 25 Figure 1.18. Low-Income Country External Borrowing and Vulnerabilities 26 Figure 1.19. US and Emerging Market Corporate Bond Spread Decomposition and Leverage 27 Figure 1.20. Long-Term Drivers of the Low-Volatility Regime 29 Figure 1.21. Leveraged and Volatility-Targeting Strategies 30 Figure 1.22. Vulnerability of the US Corporate Credit Investor Base to Shocks 31 Figure 1.23. Group of Twenty Nonfinancial Sector Credit Trends 33 Figure 1.24. Group of Twenty Nonfinancial Private Sector Borrowing 35 Figure 1.25. Group of Twenty Nonfinancial Private Sector Credit and Debt Service Ratios 36 Figure 1.26. Chinese Banking System Developments 38 Figure 1.27. China: Regulatory Tightening Has Helped Contain Financial Sector Risks 39 Figure 1.28. Chinese Banks: Financial Policy Tightening and Credit Growth Capacity 40 Figure 1.29. Bank Profitability and Liquidity Indicators 41 Figure 1.30. Global Financial Dislocation Scenario 43 Figure 1.31. Emerging Market Economy External Vulnerabilities and Corporate Leverage 45 Figure 1.1.1. Financial and Economic Cycles 48 iv International Monetary Fund | October 2017 CONTENTS Figure 2.1. Household Debt-to-GDP Ratio in Advanced and Emerging Market Economies 54 Figure 2.2. First- and Second-Round Effects of the Buildup of Household Debt on Financial Stability 57 Figure 2.3. Growth and Composition of Household Debt by Region 60 Figure 2.4. Household Debt: Evidence from Cross-Country Panel Data 61 Figure 2.5. Effects of Household Debt on GDP Growth and Consumption 64 Figure 2.6. Effects of Household Debt on GDP Growth: Robustness Tests 65 Figure 2.7. Micro-Level Evidence Corroborating the Macro Impact 66 Figure 2.8. Banking Crises and the Role of Household Debt 67 Figure 2.9. Bank Equity Returns and Household Debt 68 Figure 2.10. The Impact of Household Debt by Country and Institutional Factors 69 Figure 2.1.1. Long-Term per Capita GDP Growth and Household Debt 72 Figure 2.2.1. Characteristics of China’s Household Debt 73 Figure 2.3.1. US and Canadian Household Debt Developments and Characteristics 75 Figure 2.4.1. Panel Vector Autoregression Dynamic Analysis 77 Figure 2.4.2. Consumption Response to House Prices 78 Figure 2.5.1. Macroprudential Policy Tools and Household Credit Growth 79 Annex Figure 2.1.1. Loan Characteristics, Rules, and Regulations 82 Figure 3.1. Tighter Financial Conditions Forecast Greater Downside Tail Risk to Global Growth 97 Figure 3.2. Risk of Severe Recessions Is Especially Sensitive to a Tightening of Financial Conditions in Major Advanced and Emerging Market Economies 98 Figure 3.3. In Emerging Market Economies, Changes in Financial Conditions Also Affect Upside Risks 99 Figure 3.4. Higher Price of Risk Is a Significant Predictor of Downside Growth Risks within One Year 101 Figure 3.5. Rising Leverage Signals Higher Downside Growth Risks at Longer Time Horizons 102 Figure 3.6. Waning Global Risk Appetite Signals Imminent Downside Risks to Growth 102 Figure 3.7. Probability Densities of GDP Growth for the Depths of the Global Financial Crisis 103 Figure 3.8. In-Sample and Recursive Out-of-Sample Quantile Forecasts: One Quarter Ahead 106 Figure 3.9. In-Sample and Recursive Out-of-Sample Quantile Forecasts: Four Quarters Ahead 107 Annex Figure 3.1.1. Conditional Densities of Growth with High and Low Asset Prices—One-Period-Ahead Forecasts 110 Annex Figure 3.1.2. One-Period-Ahead GDP and Financial Conditions 111 Annex Figure 3.1.3. Asset Prices and Credit Aggregates before and after a Financial Crisis 111 Annex Figure 3.1.4.